Aug 02

Structure Product Review – Instreet Link Series XIX and XXI

Basic characteristics of these 2 structured products are…

  • They provide the investor with exposure to the S&P/ASX200 Share Price Index (ie no exposure to dividends)
  • They each have capped performance (Indicative caps are 28.5% for Series XIX and 47% for Series XXI)
  • The terms are 2 years for Series XIX and 3 years for Series XXI commencing 30 September 2010
  • The indicative Issue price is $1.49 per $10 unit of XIX and $2.35 per $10 unit of XXI
  • The return is a basket of 5 ASX listed stocks as it is a deferred purchase agreement (DPA) structure
  • Liquidity is quarterly or at the discretion of InStreet

Purchasing this investment (or should I say, “Derivative” or even “exotic Call Option”), is identical to…

  • Purchasing an “At The Money” call option on the S&P/ASX200 Share price index, PLUS
  • Writing (or selling) an “Out of the Money” call option on the S&P/ASX200 Share price index where the strike price is $12.80 for series XIX and $14.70 for series XXI
  • The terms of each call option contract is as per above characteristics, i.e. 2 years for Series XIX and 3 years for series XXI

Like purchasing any call option, exotic or otherwise, if the price performance of the underlying asset, ie. the S&P/ASX200, is less than zero at expiry, then the value of the investment is zero and all moneys are lost. So massive downside risk for this investment. 

So are these two products priced appropriately?

Series XIX

If we purchase an at the money call option in the market and at the same time sell a call option with a strike price at 28.5% out of the money, then using Black & Scholes option pricing means the net cost (excluding brokerage) is probably at most $1.10 per unit…this assumes an interest rate of anywhere between 5% and 6% and that volatility is the same for both call options…this means that because the investor is paying an indicative $1.49, being conservative, they are paying a premium of 35% (39cents/$1.10)…or 35% brokerage on the option contracts!

Series XXI

Using the same assumptions as series XIX except the call option sold has a strike price of $14.70 and the term is 3 years means the net cost (excluding brokerage) is probably at most $1.70…given the indicative cost is $2.35, we again have a hefty premium (or brokerage) of 38% (65 cents/$1.70).

Given 35 cents per transaction goes to adviser (20 cents or 2% of $10) and arranger (15 cents or 1.5% of $10), clearly this a product where the big winner is adviser and arranger (i.e. Instreet Investment Ltd) and someone else (I guess the options broker).

This demonstrates the massive margins that can occur within structured products and guess what…none of the pricing that I have shown above is disclosed….both adviser and investor is left ot ehir own resources to determine whether this investment is a good deal or not. So, the question is….given the Black & Scholes pricing used, do you think a 35% plus brokerage is worth paying for a capped call option position?

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